Category: Macro

This Week in Random Numbers

I don’t really have any new investment ‘ideas’. By ideas, I mean I’m abstaining from dart throwing. It turns out there are other interesting, but disturbing numbers out there. Here are a few from this week that are particularly wild.

  • 2,487 people in Japan have died from Covid-19. That’s fewer than the daily average in the US. Apparently they follow the 3Cs: closed spaced, crowded places, and close-contact settings. So, masks and a 2.4% obesity rate do seem to make a difference. Tokyo has a population of 38mm. They also haven’t really shut down anything.
  • 407k US soldiers died during WW2. 302k Americans have died from Covid-19. 16 million Americans served during WW2 (out of 140mm total) and there have been 16mm US (recorded) Covid cases. The comparisons can probably stop right there, but at least fewer people didn’t believe WW2 was a thing – that’s a great thing for my generation.
  • 50 bridges and 120 roads were knocked out a month ago in Honduras by two hurricanes. 175,000 people are living in makeshift shelters, 200 people died, and the total damage is equivalent to 40% of their GDP. Whoa.
  • 100 nano seconds (nano second = 1 billionth of a second) is how much time high frequency traders are looking to shave off data transmission between exchanges by using hollow-core fiber instead of glass. 10 years ago Spread Networks spent $300mm to lay a line between Chicago and New York so traders could send data back and forth with a 13 millisecond delay. And here we are watching stocks tick up and down on our RobinHood mobile app. Why even try to do anything ever?
  • 20% is how much the US money supply has grown since January this year. The M2 money supply has grown from $15.33 trillion at the end of 2019 to $18.3 trillion at the end of July. More later.
  • $150 / share is where Airbnb’s first traded after being priced at $68 / share. That puts the market cap of the unprofitable Airbnb higher than Booking Holdings, which is very profitable and has over twice the revenue. It looks like the market expects Airbnb to not only eclipse Booking Holdings, but maybe eat it entirely. Also more later.

Airbnb: Leave it Alone and Blame Me Later

Airbnb’s IPO was priced at $68 / share, but it’s first trade was at $150. It’s down to $124, which gives it a market cap of $74bn. Booking Holdings market cap is $85bn. Top line revenue bookings are $38bn vs $96bn, respectively. Booking Holdings did $5.3bn in EBITDA while Airbnb lost $253mm (those are all 2019 numbers). The only advantage Airbnb seems to have is they have almost double direct web traffic compared to Booking Holdings. Also, if you’ve never used Booking.com, it’s probably because you live in the US. It’s pretty much the standard everywhere else in the world, except maybe China, but I don’t really know. Should you buy the stock? I don’t know anything anymore. It seems dumb, but if it turns into a meme, anything can happen. I tried to read the S1, but at this valuation, what good is financial analysis. On a bullish note, the software they have open-sourced is quite impressive and shows they are a top software company and will continue to be one.

One More Thought on Inflation

The Economist had a great article on inflation last week. It basically said what I said a few weeks ago – inflation is unlikely. Yup, I made the comparison. You can read the article if you want to actually learn something, but here’s a fun thought experiment that I think illustrates their point.

Let’s say a joint costs like $10 today and you smoke about one joint per day. Let’s pretend joints have a shelf life of 7 days and you like to go to the weed store once per week. This week, you noticed there are a lot of people there and your favorite stain is running low on stock. An employee says they are having trouble sourcing more and might have to raise the price to meet high demand. Next week, the same joint might cost $15. So in order to save $35, I might buy two weeks worth of supplies. In fact, everyone at the store is thinking the same thing. Maybe I offer to pay $14 per joint today so I can save $7 over the next two weeks (everyone pays $14 this week and $15 next week).

A few things can happen next. Suppliers can grow more marijuana (increase supply), but that could take time. Demand can drop due to consumers not willing to pay higher prices (price elasticity) or consumers will learn to live with fewer joints at higher prices because they do not have enough money to afford $15 per joint – they may only buy 4 or 5 instead of 7. Fun fact: if prices go up and spending power goes down, that’s called stagflation.

The important thing to see here is that as soon as there is a perceived increase in future prices, the price rises today. Weed may or may not be ‘essential’, but things like oil, milk, wheat and metals are inelastic goods, meaning demand for those goods will not change much based on price. So if everyone thinks prices will rise tomorrow, they’ve already risen today. If everyone believes in an alternate reality, it becomes the reality.

But it ends there. It is my belief that the supply chain of the modern world can rapidly adapt to provide essential goods and services based on changing market conditions. We live in a world of abundance and there are very few essential goods that cannot increase or decrease supply rapidly. There are also countless substitute goods ready to fill in the gap in supply. This was recently challenged by the shortage of toilet paper, but that’s not too bad given the entire world changed what it buys and how it buys it over the period of a single month. If a pandemic didn’t cause massive price changes across a variety of goods affected by a global supply chain interruption and significant change in demand, a 20% increase in the money supply is unlikely to upset the demand or supply of price inelastic goods. Odds are, the ‘extra money’ will just flow into inflated asset prices, which are already owned by the rich. So rent-see may perceive a slight increase in living standards, but the rent-seekers will sop up the extra money. It’s not easy to spend $1mm, let alone $1bn and it certainly won’t be on weed, eggs or gasoline. I really don’t care about how much yachts cost these days.

What more money, but no inflation, does mean, however, is that meanies will make a few hundred dollars scalping PS5s. It is also why Airbnb and Tesla are essentially priced at their terminal value today. Maybe inflation isn’t about consumer goods prices, but asset prices and financial risk tolerance. What happens when unemployment, interest rates, cap rates and dividends all approach 0%? Maybe the word ‘economy’ will be ‘undefined’ and dropped from Webster (that’s actually the most terrible joke I’ve ever made).

What I’m Holding

I’m still holding PLTR, FUBO, and SPCE despite all the turmoil. I’m also still holding MRNA, NVAX, CTLT, CRSP, SGMO, NTLA, EDIT, VBIV, and VXRT. Biotech is seeing a lot of money right now and will continue to do so. I’m just holding and not trading. My new positions are TCEHY and U. For Tencent, I’m literally hoping that BABA’s Ant Group gets approved for it’s IPO (I hold BABA in my not-fun-safe-money-account) and that Chinese tech companies will bump. Not happening right now at all. Unity is a really cool company that makes video game software. It recently IPO’d and has been building great software since 2004. I see no reason why it’s valuation won’t get the tech IPO premium. It’s up 93% since it’s IPO and while it might have peaked recently, it can probably keep growing. Video Games are huge right now, and these guys are selling the proverbial picks and shovels. That makes us gold miners (drink on me if anyone gets the reference).

SPACs: How to Invest Pre-IPO

A SPAC is an acronym for Special Purpose Acquisition Company. Basically some yahoo raises a bunch of money through an IPO and says it will use the money to buy another company. So, I’m morally opposed to it because you’re basically giving money to someone you don’t know to buy anything and charge a large fee for doing so. However, they could buy a private company, which would effectively take that company public without said company needing to pay 7%+ to an investment bank to take their shares public and raise a bit of money. Also, banks tend to price IPOs so their customers see a huge return first day of trading (just a generalization, not the rule). As we’ve seen with recent tech IPOs, private valuations are significantly below public valuations (that wasn’t the case a few years ago – Uber being my example here). So, if you invest in a few SPACs that are nearing the end of their investment horizon, there’s a chance they buy a private tech company and their shares pop.

I’m not sure if people are doing this, but it seems reasonable. I’m having a look at PSTH, CCIV, FEAC and whatever else google comes up with. You can even buy options on these tickers. Sounds like buying a lot of chocolate bars looking for the golden ticket. But I can tell you where the golden ticket isn’t – Vanguard’s Total US Market Index.

Should We Worry About Inflation?

Oh boy inflation, what a fun topic. I’ve both wanted to write about this for a while and also dreaded it. Again, I have some time, so let’s see how this goes. Don’t worry, I won’t mention Bitcoin once.

I’m hearing people say the same things like, “rates are low right now, time to buy a house”, “the market is so overvalued right now, but I can’t invest in bonds because rates are so low”, “if the government keeps printing money, it will devalue our currency, or, inflation”, and “what are TIPS? I should buy TIPS”. Fair points, let’s address all of these things, but first a little macro economic background to set the stage. This might be review for a lot of folks, but it’s important to understand what Congress is doing when they approve a $2tr stimulus (let’s hope it’s $3tr!) and what part the Fed plays, as the Fed is responsible for inflation and adjusting economic activity to keep the markets and employment healthy. The Fed is especially important right now.

The Federal Reserve is responsible for managing the money supply in the United States. They have basically three levers they can pull to influence economic activity:

  • Bank reserve ratio requirements: Banks are required to maintain a percentage of deposits as reserves – meaning cash – every day on their balance sheet. By increasing the deposit requirement, banks maintain stronger balance sheets to protect against defaults and withdrawals, but lending activity slows. Then vice versa.
  • Overnight discount rate: This is the interest rate the fed charges banks to lend them money overnight in order to maintain required reserve ratios. By increasing the rate at which banks borrow from the Fed, rates across the entire yield curve react accordingly. Low rates stimulates economic activity via increased borrowing, but it also creates a weak dollar. To increase demand for the dollar, the Fed can increase rates which may decrease inflation. The correlation between interest rates and inflation is much more nuanced than is worth getting into here – think about the cost of imports increasing with the decreasing value of the dollar.
  • Open market operations: The Fed manages the buying and selling of government securities, namely Treasury Bonds, but they can buy and sell other securities. If Congress approves an increase in debt, the Fed can buy Treasury bonds on the open market by crediting the accounts of these private dealers. These private dealers now have more money to lend out. When the Fed sells Treasury bonds, money is taken out of the economy and the Fed pays the stated rate on the bond to the bond holder. As you can imagine, this process works in lockstep with the overnight discount rate.

The Treasury Department is responsible for actually printing money. The US Treasury collects tax dollars and uses those tax dollars to pay for government services and pay down its debt. When times are tough, the Fed buys securities on the open market, usually sold by major banks and comprise home, auto, and any other type of mortgage / loan. Instead of purchasing it with their balance sheet, they just sort of adjust the electronic cash balance these banks have with the Fed. And voila! More money is about to be put into circulation. It’s also obvious why everyone should want to be a bank. When the economy rumbles, the Fed buys shaky loans from banks to stimulate economic activity and reduce the chance of a loan default spiral and they do it with new money. No wonder bankers’ bonuses are so high.

Printing money is something that cannot be undone. If the money supply increases dramatically, demand for goods increases. As demand increases, prices increase as there are more dollars chasing the same goods. This is how hyperinflation begins and when it starts its near impossible to stop. Countries that cannot get a handle on inflation often peg their currency to the dollar to stabilize runaway inflation. And when that fails, you get Venezuela.

So why would the Fed want to curtail inflation? To protect the wealth of rich people…well and to provide stable prices for the rest of the economy. Inflation happens when demand for goods outpace supply. The price of goods increase in response to higher demand and the value of dollars in your bank account are not as valuable as they were before demand increased. As economic activity increases through lending, people buy more things at a faster rate and the price of these goods goes up. Again, this is pretty nuanced and I’m not convinced any economic models really reflect how fast production global production supply chains adapt to changing demand and how that influences inflation. Innovation, lowering costs of production, and just-in-time delivery can offset inflation, and most likely has the last decade as rates have stayed extremely low. Hence every broker you meet will tell you “rates are at an all time low, it’s a great time to buy a house”. I’m not saying they’re wrong, but there’s a lot more to it than that. Rates might not be raised significantly in the next 20 years and they may even go negative. That’s the current status of Japan.

To curb inflation, the Fed can sell Treasury Bonds to decrease the money supply. The Treasury has an obligation to pay back these bonds in the future. If inflation stays low, which is generally healthy for the economy, the cost of increasing the national debt erodes the government’s ability to pay for operating and securing the country. If they increase inflation via the mechanisms above, it hurts the accumulated wealth of anyone holding dollars, but it makes paying off debt a whole lot cheaper. Remember, as rates go up, bond prices go down. So if you’re holding fixed rate bonds and the rates increase, the par value of your bonds goes down. If inflation goes up, the Fed may raise rates to try and bring it back down. Not a lot of room for bond holders to get out alive.

That was fun. Let’s look at our current state, starting with money supply. The Fed really has no idea how much money is out there. They estimate it via monitoring the M1, M2 and MZM.

  • M1 is the money supply of currency in circulation (actual dollars)
  • M2 includes M1 in addition to saving deposits, certificates of deposit (less than $100,000), and money market deposits for individuals.
  • MZM (money with zero maturity) is the broadest component and consists of the supply of financial assets redeemable at par on demand. I usually skip this one and randomly pick either M1 or M2. It’s really about the change over time.

Remember, when the Treasury prints, say $1bn and buys mortgages from banks, the banks are only required to keep the reserve ratio in cash. If that’s, say, 10%, the banks can lend out $900mm. The $900mm is then lent out again and again. So printing $1bn can actually increase the money supply by up to $10bn. Yikes!

Here’s a chart to illustrate how the money multiplier works

When economic activity seizes up, M1 decreases because people borrow less. Less lending means fewer dollars in circulation. So that $1bn above might only translate to $2bn. Let’s have a look at the M1 over the past 60 years.

With M1, we look for sharp velocity increases to indicate risk of inflation. But note the recessions, starting in the 80s we start to see sharp decreases in the velocity of M1. We are in unprecedented times. Zero in on the most recent drop. I don’t think we need to zoom in on the chart, but look how the decrease in M1 corresponds with record household savings:

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While the Fed attempts to indirectly guide the economy through open market operations, Congress has the ability to influence it directly, and they should do more. As shown in the charts above, we are not currently at risk of increased inflation, but we have a ticking time bomb with increased savings accounts and a dramatic drop in the velocity of money. If it spikes, we will experience inflation. In my last post regarding the K-Shaped recovery, we showed how people earning $60k or more have only experienced a 3% decline in overall wages while folks earning less than $60k have experienced a 17% decrease in wages. The folks earning less than $60k are not saving, they are spending because they need to. So by giving money directly to those who need it most, we will increase economic activity, start to bring the velocity of M1 back to pre-pandemic levels and we will not put money straight into the savings accounts of bankers and tech bros. Wouldn’t you know it, it seems like the numbers are pointing towards helping the broader economy rather than just dumping it on the rich and letting the scraps fall to the floor.

However, when things open up, all the savers may all spend money at the same time and buy the same things. That is inflation folks. Also, no one is going to donate it to small businesses. So maybe here’s where Congress steps up. That’s my $.02; I’m aware no one asked.

So back to inflation. Is it a problem? Probably not. M1 and M2 money supply is so low another $2tr injected into the economy won’t increase the velocity and supply of money enough to trigger a significant increase in the price of household items, like a 5G iPhone. The reason is because the money being injected into the economy is mainly going to prop up banks’ balance sheet and won’t enter the money supply. We are probably more at risk of deflation than inflation if spending doesn’t recover, though it is expected to.

The real risk is low, or negative, interest rates. If we have negative interest rates and increase our debt to GDP ratio to pay for the cluster fuck that is the US right now, our debt obligations will actually increase over time. We don’t want the Fed to pay people to borrow from them. Also, if people still do not borrow money then the Fed is out of open market tactics to stimulate economic activity and the economy could fall into a deflationary spiral. The ECB also lowered rates in June 2014 due to a weak Euro. Negative rates encourage bond holders to rebalance their portfolio towards longer term maturities and provides incentive for riskier investments with cheap capital. Banks will struggle, but in the US they always seem to have the edge.

So why not distribute more money to those affected by the downturn and rebalance the economy. I think if we don’t do that we’re headed for anarchy. Again, just my $.02.

Rates are likely to stay low for a long time, so buying bonds is not as risky as you think and it’s a perfectly fine place to diversify. In 1997 the US introduced Treasury Inflation-Protected Securities (TIPS) as a product hedge against inflation. The principal value of a TIPS bond is adjusted based on inflation and subsequently the coupon payments are based on the adjusted principal value. They are a neat little product and make up about 2% of global financial assets. TIPS and commodities have historically been used as hedges against inflation.

If you buy equities, keep riding the tech and essential goods wave. Stay away from anything affected by the quarantine. I know real estate prices are going up and rent is going down, but I think buying anything thing that can be rent seeking will be long-term beneficial. If the government allows the K Shaped chasm to continue, income will bifurcate between those lucky enough to be on the top part of the K and those not. When the quarantine is over, those on top will have money to burn (actually if they did burn it that would help inflation) and those on the bottom will have depleted their savings. There will be an increase in renters close to economic activity centers who need to earn. Real estate prices will probably keep going up, so buy now and rent next year.

There is an interesting phenomenon here: buying a house has never been cheaper, but prices keep going up. Since supply is limited, so prices keep going up and a low interest rate just means you need to take out a bigger mortgage. If rates stay low, prices go up, and new home construction stays low, then home prices stay high. Buy now before prices get higher assuming the Fed keeps the rates locked in, which they will do for as long as it takes for the economy to return to pre-pandemic growth, M1 velocity to violently reverse its trend down, and inflation / CPI actually starts to increase.

All of this sounds pretty grim, and I really think it is. Rebalancing the economy is important for the Average Median American and we don’t track many / any statistics that represent the economic health of the Median American. The stock market sure doesn’t track that. Nor does GDP, unemployment, median earnings, or minimum wage. If we’re using poverty as metric to measure the health of the economy we are doing the whole economy thing very fucking wrong. So Fed, make some more metrics. People optimize towards the metrics they are looking at, so choose some better ones. The rest of you, manage your investments and don’t worry too much about inflation.